When Will The Fed Raise Rates?

We have an upward sloping yield curve. If we were to ignore the risk premium we could assume that this is simply due to expectations that the Fed at some point will raise rates. The first Fed funds futures contract trades at about 22bps, whereas the Mar '10 contract is trading at about 70 bps. So this suggests that the Fed will raise the Fed funds rate by about 50bps.

I think a 50bps rate hike could only happen if the Fed comes across some serious evidence that it needs to start slowing the economy down prior to Mar '10. That seems a bit unlikely.

If we look at the Eurodollar futures contract, currently the front contract trades at 1.34 bps, the Mar '10 contract trades at 1.67. The difference between the Mar '09 and Mar '10 is less than the difference between the corresponding Fed funds futures contracts. This discrepancy could possibly be explained by the fact that Eurodollar to Fed funds spreads are expected to narrow.

I think that betting against the Fed raising rates prior to Mar '10 could be profitable. Fed funds futures don't look all that liquid, but one can consider simply going long the Mar '10 Eurodollar contract. One thing to keep in mind is that if the stock market rebounds this trade will loose money but hopefully only temporarily.